The company XYZ is planning to replace an old production line with a new one. The old
Question:
The company XYZ is planning to replace an old production line with a new one. The old production line was acquired 5 years ago and it was purchased for $ 80,000. The total economic life of the machine is 8 years and the company uses straight line depreciation (the book value at the end of the economic life is zero). The old production line could be sold today at its book value. After four years, the market value of the old machine is expected to be $10,000 while the book value would be $ 0 (e.g. it is fully depreciated in accounts for tax purposes). The new production line requires an investment of $ 150,000. Similarly, the new equipment will be fully depreciated for tax purposes over its 4 year useful life, but the market value of the production line after four years can still be expected to be $ 25,000. In addition, it can be expected that replacing the old equipment with a new one will increase investments into inventories by $ 22,000 which will be recovered by the end of the project. The company's cash flow (EBITDA) is projected to increase by $ 50,000 annually when the production line is replaced. The company's required rate of return on investment is 12 (WACC). Replacing the old production line with the new one also requires moving the production to another premise for which the company just received purchase offer for $ 50,000 (ignore taxes here). If the company makes the replacement, it will have to postpone the possible sale for four years. The company tax rate (Tc) is 30. Find the incremental cashflows of the project and evaluate based on NPV if the project should be undertaken.
